Ten years on, could the GFC happen again?

Could the GFC happen again

It’s around now, ten years ago, that an apparently innocuous piece of economic information was released, triggering the greatest global economic collapse since the Great Depression 80 years prior.

That piece of information, a drop in US home sales – in fact the largest drop in US home sales in 25 years – was the first domino to fall in a chain of events that would ultimately claim people, banks and even governments.

At the time, the idea that a fall in house price sales in the US could ultimately cause Ireland or Iceland to collapse financially was unthinkable.

But it did … and the impact of those collapses still reverberates around the world today.

The US home sales data came out on January 24, 2008. But already some were feeling pressure.

In the UK, giant home lender Northern Rock faced a liquidity crisis and there was a run on the bank. By February, the British government had nationalised the lender.

But it was only a morsel of what was to come.

Inside the US, as magnificently told in the book and on film in Michael Lewis’ The Big Short – hedge fund managers who were dubious about the quality of loans banks were making to homeowners placed their bets.

To do so, they had to find something to short-sell (in other words, they would profit as the prices collapsed). The credit default swap, which pays out if a creditor defaults – like an insurance policy – was created.

The hook went in.

Behind all this was, as in Australia, an unshakeable faith in the value of homes.

Governments, banks and families share it.

To the misguided, there is a belief that home prices only go up in price. Anyone with any experience knows different. Given the right conditions – a credit drought, rising interest rates, a falling economy and mass unemployment – house prices can fall as hard as any financial asset.

A small hint of what was to come happened in mid-March, 2008, when blue-blood US investment bank Bear Stearns, on the brink of collapse, is bought out by JP Morgan.

Bear Stearns was on the wrong side of those short-sellers – and its solvency was compromised.

But as the casualties mounted, the hammer-blow came in September 2008. First, the US’ giant mortgage companies – Fannie Mae and Freddie Mac – came under enormous financial pressure.

This happened as unemployment soared in the US, and debt-stricken home owners (especially those with so-called sub-prime loans) threw the keys of their houses on their banks’ desks and walked away.

Note here the difference in US mortgages which are known as non-recourse mortgages – meaning they could walk away from their mortgage with no consequence (unlike almost all mortgages in Australia).

As Fannie Mae and Freddie Mac had written most of those mortgages, their own financial resources came to an end. This was compounded because of the hundreds of thousands of homes hitting the market all over America. The homes being foreclosed could not be sold, leading to even greater falls in house price values – even more unemployment.

The problem compounded over and over.

To give you a hint of the magnitude of the problem, Fannie Mae had sold $2.1 trillion worth of mortgage back securities – and very quickly. These had collapsed in value.

The US government bailed out Fannie Mae and Freddie Mac. But it was not the end.

The largest US insurer, American International Group, with a trillion dollars’ worth of assets, teetered on the brink of collapse with a loss in 2008 of $99 billion. Think about that – $99 billion, in one year. It eventually gained Federal Reserve aid of $182 billion, to avoid collapse, and ultimately paid the government back $205 billion.

Even today, it remains a shadow of its former self.

But the crisis reached a peak in mid-September when one of the bluest of blue-blood Wall Street firms, Lehman Brothers, filed for bankruptcy with $639 billion in assets and $619 billion in debt.

Its problem? Sub-prime mortgages.

Oddly, in 2007, as US housing started to crack, Lehman reported its housing risks were well contained. It was so wrong.

In the first week of September 2008, Lehman Bros shares collapsed 77 percent as it entered its death-roll. Last-ditch attempts to save it via a takeover by Barclays failed. On Monday September 15, Lehman Bros collapsed, with the US government – unlike Bear Stearns – not stepping in to save it.

The collapse led to Merrill Lynch to be bought by the Bank of America, setting off a chain of events around the world that saw the collapse – or near-collapse – of some of the world’s largest banks, including Royal Bank of Scotland, HBOS (owner of BankWest which was acquired cheaply by the Commonwealth Bank).

The debts that governments took on to save these banks and to restore confidence in communities worried another Great Depression was upon them saw trillions upon trillions of dollars borrowed.

Interest rates fell to zero and budgets were destroyed (the USA, incredibly, lost its Triple A credit rating).

Ten years on, those trillions of dollars of debt have not disappeared. Interest rates, broadly, are still at record lows and in some cases (RBOS) banks are still under government supervision.

Even today, the impact of banks lending money to poor families in the US that had no means of repaying them is having repercussions in the way government and all people behave.

The big question is, have the lessons been learned?

This weekend, take the time to watch Inside Job, the Academy Award-winning documentary of the Global Financial Crisis (GFC) and get Michael Lewis’ book, The Big Short.

They will both guide you around the greatest influence on our economy – and your lifestyle – in the past decade.

Ross Greenwood speaks to Assistant Governor of Business Services at the RBA, Lindsay Boulton, about the Australia’s most counterfeited note having a makeover Interview with: Lindsay Boulton, Assistant...

About The Author

Ross Greenwood is the Nine Network’s business and finance editor, and hosts Sydney's top-rating radio program, Money News, for 2GB, 4BC. 3AW and all networked stations across the Macquarie Media group.
He appears daily on the Today Show - notably for his Money Minute - and Nine News.